Why Fund Managers Are Worth Listening To

published 30 May 2006

Let me give it to you straight - your fund manager doesn't have a clue where stocks are headed In fact, I like to use fund managers as a contrary indicator for what to do when it comes to my investments. Why? Because it works.

It's amazing how bad fund managers are at timing the market. Literally, a coin flip would have done a much better job of choosing when to be in the market than all of our fund managers. The coin flip would have won by a wide margin.

Even worse, in running the numbers lately, I discovered a real danger sign You see, right now mutual fund managers, based on one measure, are more optimistic on the stock market than they have been at any time in the last 30 years.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

https://cdn.mos.cms.futurecdn.net/flexiimages/mw70aro6gl1676370748.jpg

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Actually, I take that back - there was one other month that tied the latest reading March, 2000. The exact month that the Nasdaq 100 index started its 80%-plus decline Could stocks crash again? With the awful track record mutual fund managers have in timing the market, I wouldn't bet against it.

Fund Managers Do It All Wrong

Fund managers are fully invested at the top of the market, and have tons of cash at market bottoms.

It's the brutal truth. And the numbers really make fund managers look bad.

When fund managers have a ton of cash on hand - say, more than 9.5% of the fund's assets in cash - then stocks actually do extremely well.

Going back to 1970, fund managers were scared of stocks and therefore held more than 9.5% of their funds in cash roughly 20% of the time. Instead of being scared, the fund managers should have been taking that cash and buying up stocks! On average, when fund managers had more than 9.5% of the fund's assets in cash, the stock market was up by an astounding 18% just 12 months later. And the opposite is true, too. When fund managers have very little cash (say, less than 6% of assets in cash, which occurred 27% of the time), then stocks do terribly. On average, stocks were up 1.2% 12 months later.

So stocks did great when mutual fund managers were playing it safe, holding a lot of cash. And when mutual fund managers were rolling the dice, being fully invested to try and bring home big returns, stocks barely made any money Have you lost respect for fund managers yet Consider these examples. You'd have made a killing in stocks if you'd bought at the beginning of the 1990s - particularly during the 1990-1991 recession. Instead of buying, fund managers were scared. They had 12.9% of their assets in cash. They should have been buying, not hiding in cash.

As the market rose through the 1990s, mutual fund managers got more bold - and complacent. By March of 2000, fund managers held only 4.0% of their assets in cash. That month was the all time low, and it corresponds with the all-time peak in the Nasdaq.

It's only taken about five years, but fund managers are back, and they're as optimistic as ever. The reading for June 2005 shows fund managers have just 4.0% of their assets in cash. Again, this ties March of 2000 for the lowest reading in 30 years. And with stocks hitting new highs these days, when the July reading comes out, we could see a 30-year record for optimism!

What This Means for You and Me

It should be obvious. Fund managers are holding less cash as a percentage of their assets than they have in the last 30 years. And fund managers have proven to be terrible 'market timers,' having too much cash in stocks at the top of the market Even when you adjust the cash level for interest rates,the picture right now is downright scary. But the thing about measuring sentiment is, it's more art than science. And it's extremely difficult to use sentiment to time trades.

It's better to think of sentiment gauges like this one as one piece of the puzzle when it comes to analyzing stocks.

Unfortunately, many of the puzzle pieces all suggest lower stock prices ahead - we've got $60 oil, an overvalued stock market, and now we've got overly-optimistic investors too. Not a good recipe. The only thing going up is, well, the current trend in stock prices. And that's a trend you don't want to fight.

Without committing to a prediction, and without wishing to buck the trend, let me just say that stocks may not do so well in the coming 12 months. And it may be a smart move to lighten your load in equities, if this move in stocks looks like it's running out of gas.

By Dr. Steve SjuggeruChairman, Investment US